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Ovoca Gold caught my eye recently when I was cruising for new stock ideas. I came across Ovoca through applying a filter Enterprise Value < 50% Market Capitalisation (MC). Enterprise Value (EV) looks at Market Capitalisation and then adds debt and subtracts cash. EV is therefore the true market value of a business. An EV 50% lower than MC normally implies a company without debt and holding a large balance of cash. Ovoca though with further research I soon spotted was off the scale, right around the first time I looked into this an excellent article also appeared on ShareProphets. In summary not only does Ovoca have a cash balance almost justifying the market capitalisation it also has a hell of a lot of liquid investments in a FTSE100 miner. Well worth a look then….
What’s the background?
Ovoca has been around for 30 years, incorporated in 1985 and has been involved with numerous mining developments. The largest was the Goltsovoye Silver project which was disposed in 2008 to Polymetal for around $30m. Another more recent disposal was made in 2012, this time Olcha for $13.5m, again to Polymetal. This explains why Ovoca has shares in Polymetal, currently worth £10.5m on it’s balance sheet.
Since then Ovoca has been looking for new opportunities for investment. One recent opportunity did not work out quiet so well though, Ovoca provided Taymura LLC a loan of US$6,345,000. In return Ovoca received an exclusive period to complete due diligence on JSC Evenkiya Fuel and Energy Company (ETEK) and LLC Taymura. The loan was never repaid and LLC Taymura was placed into bankruptcy. Since then $1m has been recovered and the remainder of loan has now been fully impaired, this calling into question any further recovery.
The company also has Stakhanovsky licence. This is covered further below in upsides.
What is a realistic Valuation for Ovoca?
The share price of 8.5p represents a whopping discount of almost 60% to liquid assets. The shares should be trading at around 21p based on the company’s liquid assets (see fig 1 below for valuation). This kind of discount I can only recall seeing on some of the AIM China stocks. The difference here is that Ovoca has a long history during which it has delivered several projects. Ovoca in fact also still counts positive retained earnings as at the end of 2015, they are slim granted but this puts Ovoca in a elite few on AIM!
Why is the valuation so depressed?
The issue of a poor investment in LLC Taymura has clearly knocked investor confidence and with a lack of meaningful investment activity since I can understand a discount to cash for 1) poor sentiment and 2) to account for ongoing costs net of finance income of £0.75m per annum. So taking this into account let’s accept 17.5p feels more reasonable, however this is still 100% upside on current share price.
Any further upsides?
As mentioned above the company has the Stakhanovsky licence, a gold exploitation license is situated in the north-western part of the Magadan Region, covering an area of 73 km2. Ovoca holds at historical cost on the balance sheet the exploration efforts so far at $1.8m. The licence is currently mothballed with limited work have been done in the last financial year. A summary of the competent persons report resource estimates are below in Fig 2.
The grade of the mine is fairly low. Total resources are 327,000 ounces, at current spot price per ounce of $1,176 this gives a potential value of gold in the ground of $385m, although it is early days and there are no indications of costs to get this mine producing but a low grade implies a higher cost to get the gold out of the ground. There is though infrastructure nearby and the open pit format of the mine may assist in keeping costs low.
The World Gold Council defines a high-quality underground mine as having a gold ore density between 8 and 10 g/t (grams per tonne), while a low-quality underground mine has a gold ore density of 1 to 4 g/t. (Source)
Whilst not an uninteresting asset very little value can be assigned to Stakhanovsky at this stage. More detailed feasibility work is needed to give an indication of the economic viability.
The other major upside would be recovering further amounts of the $5.3m it is owed. Ovoca does have various security and guarantees, but the fact the asset has now been written off means it is not certain that any further recovery will occur, but Ovoca advises “it will rigorously pursue all available options to recover the full loan amount and the company has already taken steps to pursue the personal guarantees which were used to secure the loan. The directors believe that substantially the entire loan will be recovered.”
Is this to good to be true? What about the risks?
Liquidity is an issue on this stock, although this is not uncommon on undervalued micro caps. By definition they are unloved and therefore have low volume. Just £65,000 worth of stock changed hands during November, accounting for 1% of the total market capitalisation. It’s no surprise that the spread on this stock is 15% and any large buys or sells has the ability to create wild swings in the price.
It’s investment in Polymetal is also a major part of the valuation so any declines in share price of Polymetal will clearly have a knock on effect here, a decline in the gold price is clearly the biggest risk in this respect.
There are potential major re rate triggers here, further updates on Stakhanovsky, a new investment opportunity, further recovery of the loan and a significant uptick in the gold price all have the potential to attract investor interest. Counter to this though is also a risk of further share price drift, Ovoca does not put out many updates and as shareholders get bored and move on this could create downwards pressure on the share price.
BUY – Target 17.5p, add below 12.5p.
I would not fill my portfolio will smaller illiquid stocks like this, but I believe there is a fairly good opportunity here to turn a profit, but one needs to have a reasonably long horizon.
Disclaimer – I have a LONG position equal to 0.5% of my net assets in Ovoca Gold. To my knowledge no close family, friends nor associates have any further positions. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.